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Senate Banking Committee Hearing with Prudential Regulators

Senate Committee on Banking, Housing, and Urban Affairs

“Oversight of Financial Regulators”

Thursday, December 5, 2019

 

Key Topics & Takeaways

  • Liquidity Coverage Ratio: Quarles stated that the LCR for the GSIBs was not lowered and S. 2155 included a mandate to tailor for all financial institutions, including regional banks. He continued that the Fed evaluates the risks of different institutions and then tailors requirements in accordance with the amount of risk that they pose. As such, there are lower liquidity requirements for institutions that pose less risk. He concluded that liquidity writ large remains high, significantly higher than pre-crisis levels.
  • Volcker Rule: Quarles and McWilliams reiterated their commitment to examine and solve the issue regarding the ‘covered funds’ definition and provision.
  • Systemic Risk & GSIBs: Quarles stated that in constructing the post-crisis regulatory and supervisory framework, current and future regulators have, and will have, many more resolution tools at their disposal when dealing with events of stress at a large financial institution.

Witnesses

Opening Statements                   

Chairman Mike Crapo (R-Idaho)

In his opening statement, Crapo noted that a year has passed since the enactment of S. 2155, the Economic Growth, Regulatory Relief and Consumer Protection Act, and that the prudential regulators have worked to implement most of the law’s provisions. He specifically noted the tailoring rules for U.S. banks and the U.S. operations of foreign banks. He encouraged regulators to continue to review the existing supervisory frameworks and make any necessary adjustments to better align with the tailoring rules and requirements. He thanked the regulators for action on many of the outstanding provisions of S. 2155 raised in his July 30, 2019 letter including the community bank leverage ratio, short-form call reports and the tailoring of other regulations to promote further economic growth such as addressing the current expected credit losses (CECL) standard, the Volcker Rule and inter-affiliate margin. While he noted his appreciation for the issuance of a proposal that revises several aspects of the Volcker Rule, he emphasized the need to address the ‘covered funds’ provision as it remains overly broad. Crapo then referenced the repo rates spike in September, noting that some have suggested that certain aspects of the Federal Reserve’s (Fed) supervisory and regulatory framework may have exacerbated this spike, and specifically points to the treatment of cash versus treasuries. He encouraged the Fed to look for potential long-term fixes in addition to their short-term actions in buying Treasuries and lending funds. He recommended that the prudential regulators take the necessary steps to rectify informal guidance that has not been submitted to Congress.

Ranking Member Sherrod Brown (D-Ohio)

In his opening statement, Brown first noted his concern regarding the expended changes to the Community Reinvestment Act (CRA) coming out of the Office of the Comptroller of the Currency (OCC) before outlining that the regulators are allowing the banking industry “to get back to its old tricks” that he believes led to the 2008 financial crisis. He then decried the behavior of the private equity industry, specifically regarding the use of leveraged loans, collateralized loan obligations and leveraged buyouts, which “is looking for profits anywhere it can find them, and these schemes squeeze money out of every part of the economy.” He emphasized that the duty of the regulators is to protect the economy and the financial system, not profits for financial institutions and large corporations.

Testimony

The Honorable Randal Quarles, Vice Chairman of Supervision, Board of Governors of the Federal Reserve System

In his testimony, Quarles gave an overview of the steps the Fed has taken to implement S. 2155, the Economic Growth, Regulatory Relief, and Consumer Protection Act, saying there is a continuing need to ensure the regulatory framework is “coherent and effective.” Quarles explained that the Fed’s recent Supervision and Regulation Report shows that the banking sector is stable, healthy and resilient with robust capital and liquidity positions. He continued that there have been steady improvements to safety and soundness, adding that there has been a gradual decline in supervisory actions at both large and small institutions. He said the Fed is continuing to focus on operational resiliency and cyber-related risks, emphasizing these are among the Fed’s top priorities for the coming year. He stated the Fed has tailored its rules for regional banks and has worked with other agencies to address a range of issues affecting small and community banks, including stress testing requirements and the Volcker rule. Quarles noted that the Fed is paying particular attention to proposed changes to the stress capital buffer, the implementation of Basel III, the transition from LIBOR, the need to “thoughtfully” address new financial products and technologies, and the need for cross-border coherence.

The Honorable Jelena McWilliams, Chairman, Federal Deposit Insurance Corporation

In her testimony, McWilliams said under her leadership the Federal Deposit Insurance Corporation (FDIC) has made significant progress in strengthening the banking system, ensuring that FDIC-supervised institutions can meet the needs of consumers and businesses, and fostering technology solutions and encouraging innovation at community banks and the FDIC. She said the U.S. banking industry has experienced an extended period of economic growth, noting that the industry is strong and well-positioned to continue to support the U.S. economy. She said that the current interest rate environment may result in new challenges for banks in lending and funding, though the industry is well-positioned to remain resilient throughout the economic cycle due to greater and higher-quality equity capital. McWilliams explained that the FDIC is working to further strengthen the banking system by modernizing its approach to supervision and increasing transparency, tailoring regulations including enhanced prudential standards, stress testing, resolution planning, and the Volcker rule, enhancing resolution preparedness including cross-border cooperation, assessing new and emerging risks including cyber risks and anti-money laundering (AML) issues, and creating a workforce for the future.

The Honorable Rodney Hood, Chairman, National Credit Union Administration

In his testimony, Hood said the credit union industry is strong and the National Credit Union Administration (NCUA) is working to ensure a safe and sound credit union system and provide a regulatory framework that is transparent, efficient and improves customer access. Hood said that the NCUA’s examination and supervision program provides for active risk management and early detection of problems, adding that this is critical to preserving the financial strength and well-being of the system. He noted a number of cybersecurity initiatives the NCUA is undertaking, including programs to ensure credit unions have the resources necessary to improve their preparedness and resiliency. Hood noted that the NCUA is also working to reduce, streamline, or eliminate outdated or overly burdensome regulations where possible, including on issues such as bylaw modernization, public unit and nonmember shares, and payday alternatives. Hood also highlighted efforts underway at the NCUA to promote diversity and inclusion including credit union self-assessment tools and initiatives to address supplier diversity.

Question & Answer

Liquidity Coverage Ratio

Sen. Bob Menendez (D-N.J) asked Quarles why the regulators have opted to lower the liquidity coverage ratio (LCR). Quarles responded that the LCR for the global systemically important banks (GSIBs) was not lowered and that S. 2155 included a mandate to tailor for all financial institutions, including regional banks. He continued that the Fed evaluates the risks of different institutions and then tailors requirements in accordance with the amount of risk that they pose. As such, there are lower liquidity requirements for institutions that pose less risk. He concluded that liquidity writ large remains high, significantly higher than pre-crisis levels.

Volcker Rule

In a response to an inquiry from Crapo, both Quarles and McWilliams reiterated their commitment to examine and solve the issue regarding the ‘covered funds’ definition and provision.

General Prudential Regulation & Transparency

Brown asked Quarles what steps the Fed is taking to reign in risks and ensure that financial institutions are investing in the real economy and contributing to the creation of jobs. Quarles responded that bolstering the safety and soundness of the financial system is the responsibility of the Fed and that the factors referenced by Brown are a part of their process in constructing the supervisory framework. Sen. Thom Tillis (R-N.C.) took the opportunity to praise the recent rulemaking issued by the regulators regarding Inter-Affiliate Initial Margin (IA-IM) as well as the FDIC’s efforts to issue guidance and supervision in a more transparent and accountable manner.

In his response to a question from Sen. Richard Shelby (R-Ala.) asking for an assessment of the overall health of the financial system, Quarles, McWilliams and Hood all stated that the financial system is stronger for both large and small banks. Specifically, Quarles noted the significantly high levels of capital and liquidity as well as the increased focus of the Fed on the resolvability of institutions in order to mitigate the problem of ‘too-big-to-fail’. He continued that because of the current strength of the financial sector, the Fed has the opportunity to examine and determine where the regulatory and supervisory framework can be made simpler and more efficient while maintaining the same level of resilience. Quarles referenced the final minimum total loss-absorbing capacity (TLAC) and its’ combination into the stress capital buffer as an example of making regulation simpler while maintaining resiliency.

Leveraged Loans

Brown noted that private equity firms are the biggest users of leveraged lending practices and reiterated his belief that they are not only users, but abusers of leveraged lending, which in turn harms both individuals and communities. He asked Quarles how the Fed views leveraged lending and the risks that he believes accompanies such behavior. Quarles emphasized that he supports a system in which private equity investment brings benefits to the companies that they are investing in. He continued that supervisory action by the Fed has already been taken with respect to leveraged lending and that in doing so, the Fed is attempting to draw a distinction between what constitutes a financial stability risk vs. what constitutes a potential contribution to a future business downturn due to current underwriting practices. Quarles concluded that the past two National Credit Examinations have focused on leveraged lending and the evolution of underwriting practices.

Systemic Risk & GSIBs

Sen. John Kennedy (R-La.) asked Quarles whether he believes that we still have financial institutions that are too big to fail. Quarles responded that in constructing the post-crisis regulatory and supervisory framework, current and future regulators have, and will have, many more resolution tools at their disposal when dealing with events of stress at a large financial institution.

Brown stated that when the committee was considering S. 2155, Chairman Powell pledged that the bill would not require the removal of rules for foreign megabanks. He continued that despite this statement, the Fed and FDIC have proceeded to loosen rules of foreign banks. Quarles responded that S. 2155 did not instruct or require that the Fed make those adjustments but that other elements of banking law require that they take national treatment into account. As such, frameworks will not be the same in terms of domestic and foreign banks. McWilliams stated that she instructed FDIC staff to examine various capital and liquidity rules and cross-reference those with sections in S. 2155 to determine whether there is an opportunity to amend such rules.

Community Reinvestment Act

Sens. Menendez , Tillis, Catherine Cortez-Masto (D-Nev.) and Mark Warner (D-Va.) asked about the FDIC’s work to modernize the CRA and whether the agencies are working together on a path forward. McWilliams responded that the proposal is still being worked on and summarized the main goals in this modernization. She specifically referenced the fact that with the increase in digital banking, there are now digital delivery channels for banks that are not accounted for in the correct assessment areas. She hopes that this modernization will allow these areas to be served by the CRA. In response to a question from Cortez-Masto, McWilliams reiterated that she hopes this modernization effort will help close the home ownership gap that exists amongst minorities.  Quarles, in responses to questions from Tillis and Warner, stated that the Fed has been engaged at the governor level with the other regulators and that the proposal that is evolving has benefited from a significant amount of Fed input.  He continued that the effort to modernize the CRA is spread amongst all regulators and that while different regulators may proceed on different timelines throughout this process, the end goal is to produce a final rule together.

Industrial Loan Companies

Kennedy requested an update from McWilliams on the FDIC’s regulation of industrial loan companies (ILCs). Kennedy emphasized his desire to subject ILCs to the same regulations and oversight as traditional banks the same as traditional banking institutions, referencing his bill, S. 2839, the Eliminating Corporate Shadow Banking Act of 2019. McWilliams responded that when Congress gave the FDIC authority to approve deposit insurance for ILC, it gave the same statutory standards as it did for banking institutions.

Digital Currencies

Crapo and Cortez-Masto asked questions concerning digital currencies with Crapo specifically noting his concern that they might undermine the role of the U.S. dollar in global markets. Quarles emphasized that this may be a long-term concern and that the Fed is examining digital currencies with increased scrutiny given the recent interest in Stablecoins.

For more information on this hearing, please click here.

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